Loans

Don’t Put the Car Before the House

The next time you’re in the market for a car, nowhere will you ever see a disclosure or a word of caution from the salesman about how financing that car could hurt your future chances for buying a house.

Unfortunately, auto loans will affect your ability to purchase a house no matter how big or small the loan is. Lenders account for all liability payments the same. It’s not what you owe, but what you pay that counts.

So you could have a car loan for $30,000 and your balance has no bearing on your ability to close on a house; rather, it’s the payment associated with that balance that changes the game. This is key, especially if you proactively prepay your auto loan in an effort to pay off the debt faster. If you choose to pay more, that’s your prerogative, but for the purposes of qualifying for a mortgage, the minimum payments are king.

As for whether you lease or finance the car, it’s all the same. Let’s say you have a car payment for $500 per month and you have two more years left on your lease. That would be the same as if you had a personal car loan for $500 per month with a longer-term obligation. The same reasoning applies to both: The minimum payment is what lenders will use to calculate how the liability will affect your ability to purchase a home.

How Auto Loans Affect Your Credit Score

Having a clean auto loan payment history will do wonders for your credit score, and a favorable credit rating will actually help you qualify for a mortgage. Conversely, late auto loan payments can destroy a credit score, which can kill your chances of getting a mortgage.

Your credit score should be a minimum of 620 to qualify for a mortgage these days. Understand if your credit scores land in the 620 range, the lender is going to pay very close attention to your credit history as well as your capacity to handle a mortgage payment. They’re going to keep a particularly close eye on any pattern of payments related to any car loan you presently have or have had in the past, moreover what those patterns reveal about whether you tend to pay on time, as agreed.

Your payment history is the most important component of your credit score – so late payments can cause your scores to drop in a big way. Most people check their credit scores before they buy a home, and then find out too late that they have not-so-great credit, leaving themselves little time to improve it. It’s a good idea to make monitoring your credit scores a part of your financial routine so that when you are ready to buy a house, you’ll be better prepared to work within your credit standing. You can monitor your credit scores for free on Credit.com, where you can get two credit scores, updated every month, with a plan to help you meet your credit goals.

How Your Buying Power Is Affected

Your buying power is measured as the spread (difference) between income and liability payments. The bigger this gap is, the more room you have to accommodate a mortgage payment.

So if you have payment obligations and your income is four times the amount of the minimum monthly payments, that’s a healthy financial position to be in.

Here’s how it works: For a typical ratio of 2:1, it’s every two dollars of income to offset one dollar of debt. For example if you have car loan payment at $400 per month, in order for that payment to not hurt your ability to buy a house, you need $800 in income to offset that debt.

In practicality, the next time you’re at the car dealership and you’re taking on a $400 per month car payment, and you know buying house is in your future, talk to your employer about that $9,600/year raise or promotion you are eligible for. (With a $400/month car payment, that’s means you’ll need $800/month to cover the liability and meet the ratio.)

Quick mathematical takeaways for what lenders look for regarding expenses-to-income:

Each $100,000 financed is equivalent to $725 per month of a mortgage payment

Every .125 in rate on every $100,000 financed adds $7.25 to the monthly payment

Each $500 of a mortgage payment translates to upwards of $65,000 in home price

Buy House or Buy a Car First?

In short, whether or not you buy a car first depends on how far away you are from closing escrow on a house. If it’s a longer-term projection for getting your keys, and your income is poised to rise, it may make sense to wait and purchase a house later on when your financial situation is more grounded. On the other hand, if you know you need to buy a car and buying a house could happen in the very near future, buy the house first when your liabilities are lower. Because qualifying for a car loan does not require the extent of credit analysis a home purchase does, it makes more sense to close on the house first before you buy the car.

If the car purchase can’t wait and a home purchase is in the near future, first see how you qualify with a lender to determine if you can qualify for the desired purchase price amount given your credit score, down payment capability, assets and debt ratio (amount of current debt + proposed mortgage payment ÷ monthly income). If you have trouble qualifying for your desired purchase amount, you’ll need to pay down your debt in an effort to qualify – if that’s an option for you.

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Paying Off Debt Pitfalls

Would-be buyers take heed…

Not all lenders allow you to pay off debt to qualify for a home loan. Some lenders might require you to pay off debt to qualify and subsequently close the account. Others simply won’t allow it, wherein you would have to pay off the liability first in full and then have the lender pull a new credit report for you. Doing this may not necessarily adversely affect your credit score, so long as you’re not applying for different types of credit around the same time you’re applying for a home loan.

Lastly, if your pre-tax income is eroded by consumer debt like auto loans, credit cards or personal loans, a lender may ask for you to make a bigger down payment, pay off the debt entirely, increase your income or obtain a co-signer.

More on Mortgages and Homebuying:

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Scott Sheldon is a senior loan officer and consumer advocate based in Santa Rosa, Cali. His work has appeared in Yahoo! Homes, CNN Money, MarketWatch and The Wall Street Journal. Connect with him at Sonoma County Mortgages. More by Scott Sheldon

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